The industry estimates that falling crude oil prices, lower fuel subsidies along with recent diesel tax hikes could together add almost Rs 1.1 trillion to the Union Budget. And with the government planning to spend about $8 billion of that on infrastructure and manufacturing activities, the infrastructure sector is looking at a brighter year ahead.
The election results with the majority government at the Center have resulted in a renewed optimism in the Indian economy. This optimism brings many expectations from the government. Infrastructure is one of the key needs of the hour and one of the key spend items of the government to regnite the economic growth cycle.
As we experience a resurgence in economic activity in India, is it the time of the year when the Finance Minister is expected to give further impetus to ´Resurgent India´ with the Union Budget 2015-16?
In this article, we have detailed an analysis of the outcomes of some of the key proposals of the Union Budget 2014, and the industry´s expectations from the Union Finance Minister as it relates to the infrastructure sector in India.
As it stands, the infrastructure sector is looking at substantial interventions from the government to seed critical investments in sectors like railways and other transport, and across the board regulatory reforms and harmonization.
In our view, one of the drivers of progress across sectors in power, gas, coal, aviation and transport is enhanced regulation. Further, critical institutions/regulators need capacity-building and reform to deal with the issues facing each of these sub-sectors.
Roads, Highways and Bridges
Of the 239 projects covering 21,747 km awarded by NHAI until November 2013, only 77 projects or 32 per cent are fully complete. At the end of 2014, approximately 10 to 15 per cent of these projects were yet to receive appointed dates from NHAI. The current issues facing the sector can be attributed to overoptimistic bids by private sector participants; challenges for NHAI/government to meet its land acquisition obligations; resistance from users to pay toll in certain States; and historical delay in completion of projects. These matters have impacted project costs and therefore, viability of many projects.
While the Union Budget 2015 detailed an investment outlay of Rs 37,880 crore in NHAI and State Roads (including Rs 3,000 crore for the North East) and a target of 8,500 km of NH construction to be achieved in the current financial year, a significant spend of this expenditure was expected to be driven through the Engineering, Procurement and Construction (EPC) route.
Given the resource constraint facing any Indian Finance Minister, the extent of construction possible under execution of projects under the EPC model is limited. It is imperative that the new government resolve the challenges facing the existing PPP investors and attract fresh foreign capital to fund new bids. In our view, certain important steps are needed to be implemented to resolve issues currently facing this sector. These include:
Creation of capacity on balance sheets to bid for new projects-currently most developers´ balance sheets are highly leveraged due to a combination of factors including aggressive bids, project delays and traffic being affected by industrial growth being lower than expected. Further, the concession agreements have restrictions on transfer of shareholding in assets and the government could consider relaxing some of these to enable developers to release some capital which will create capacity to bid for new projects.
Further, where the traffic on roads is dependent on larger capital projects like airports, etc., which have uncertain development and operation timelines, the government could consider having a hybrid model where these roads are annuity projects till the underlying developments that affect toll are fully operational. This will provide more comfort to the developers of these projects at the time of bidding and in the initial years of operations.
Indian Railways is one of the integral elements that drive the Indian economy and serves as the lifeline for cargo movement across the country. The new Minister of Railways has set out on an agenda to increase private participation in Indian Railways with a mission to improve customer service and safety.
Some of the key initiatives that have driven interest from private participants (given the large spend amounts) are:
A lot of expectations ride on the Railway Budget this year that will pave way for wide-ranging reforms in Indian Railways, on what would form an integral part to the ´Resurgent India´ theme. Further, any tax incentives that the Union Budget may provide for the sector may also help increase participation.
Development of non-major ports due to growing private sector participation has led to cargo shift from major ports. As a result, the contribution of non-major ports to total cargo traffic is expected to increase further from 42 per cent in FY13 to 45 per cent in FY17. This is also due to congestion faced at major ports, where utilization levels for coal, fertilizers and containers are currently 132 per cent, 161 per cent and 86 per cent which are unsustainable and results in operational inefficiencies. High rate of capacity addition and moderate traffic growth are the key reasons for the decline in utilization levels at non-major ports. Increase in coal imports, higher exports resulting from the emphasis of ´Make in India´ and container trade is likely to reverse the decline.
PPP is expected to play an important role in the ports sector, especially in development of non-major ports. Private investment is expected to contribute 66 per cent and 98 per cent of total investments in major and non-major port projects respectively.
Around 41 per cent of the total investments during 2010-20 is expected in the east coast, where non-major port projects are expected to account for 57 per cent of the total capacity addition.
Policy uncertainty on several fronts continues to be a challenge in the ports sector. Regulatory clearances such as environmental and security are creating bottlenecks for capacity expansion. Infrastructure status for coastal shipping has been a long pending demand. This could help the sector in getting easier credit at lower rates, increase private investment and result in faster regulatory clearances Lack of clarity on guidelines for determination of tariffs by TAMP is one of the key challenges for growth and development of major ports despite revisions in the 2013 guidelines. While the sector has had announcements of the Sagar Mala project, which would allow the Central government to direct development of non-major ports (a State subject), without confronting the State governments and an emphasis on inland water transportation, the industry also expects concrete announcements to implement some of the plans of the government.
Given the shortages of domestic coal, imported coal volumes are likely to increase significantly to between 150 and 200 million tonnes (mt) annually. While the process of building out new greenfield ports is likely to take longer given land acquisition, regulatory clearances etc., the government could consider regulatory measures to incentive debottlenecking and expansion at existing ports.
Airports serve as a gateway to any country. Given the government´s emphasis on tourism and economic development, the Finance Minister needs to solve some of the key challenges facing the current private airport developers, who have undertaken large privatization projects.
The sector is currently faced with an urgent need for a predictable and investor-friendly regulatory regime especially around single till or hybrid models at airports to create renewed interest in this sector.
Secondly, while the Union Budget 2015 detailed the proposal for a scheme for development of new airports in Tier I and Tier II cities, there have not been sufficient steps implemented to resolve the issues around the revenue models.
The airport operator and global investor community will look for concrete steps in this regard before further investor interest is generated for modernization of existing AAI-run airports and the proposed greenfield airports in Mumbai, Greater Noida, Goa etc.
Urban transportation and other urban infrastructure
Increasing urban population, need for mobility and expansion of cities in the past decade have resulted in an exponential increase in the need for urban transportation in the country, which in most cities is served by additional cars and buses on roads. Lack of planning and foresight on city and population growth has meant that the current infrastructure has been grossly insufficient to meet urban transportation demands.
The current need of the urban transportation sector is for high quality urban transportation options like the Metro; improve existing public transportation infrastructure and reduce the use of personal modes of transportation.
The emphasis of Union Budget 2015 was to finance Metro projects; the Finance Minister would be expected to announce a slew of measures focused at transportation solutions for major cities including the metros and Tier II cities in India.
As per National Action Plan on Climate Change (NAPCC) guidelines, an RPO of 15 per cent is targeted to be achieved by 2020. This translates into 71 GW of renewable capacity addition to be met by FY20. If we were to consider the demand projections by CEA, the renewable capacity required to meet these targets is 100 GW by FY20.
Wind power is an attractive investment proposition in India with generation costs achieving grid parity in most States. Investor sentiment is looking strong with attractive feed-in tariffs in States like Maharashtra, Rajasthan and Madhya Pradesh and reintroduction of Generation Based Incentives.
On solar, the Narendra Modi government is seeking investments to the tune of $100 billion over the next seven years to boost India´s solar capacity to 100,000 MW. There is renewed interest from global companies with manufacturing capabilities to set up factories in India that would cater to the needs of developers in this space. In Phase 1, the National Solar Mission has been successful in providing incentives for setting up of large number of solar power projects and minimizing the impact of tariff on the distribution companies.
A further 3,000 MW solar PV projects to be selected in Phase 2 are expected to be implemented on land provided by State governments or developers in the respective States.
Around 25 solar parks are being set up to facilitate solar capacity addition across various States. The developer would then be expected to approach the Solar Park Implementation Agency for allotment of land and connectivity. Since the costs of land, charges etc., are expected to be fixed, the bids from developers are expected to be competitive. One of the concerns facing the sector currently is the evacuation system for wind projects, which given high variations in generation in seasons, requires additional redundancy to be created in power evacuation and therefore a need for additional investments in the transmission systems. States of Tamil Nadu and Rajasthan experience evacuation failures/constraints resulting in low PLFs and loss of generation during peak months.
Another concern facing both the wind and solar developer communities is policy clarity on PPAs and RPO frameworks. Enforcement of RPO obligations on State utilities continues to be a challenge in realizing the REC benefits available to developers.
While economics of wind and solar projects have improved in the context of fuel constraints faced by thermal power plants, implementation of defined measures to mitigate some of the key challenges will be critical for this sector.
India would require an additional installed capacity of about 212,000 MW by FY22 to meet 100 per cent peak demand. While this will create significant opportunities in the power generation, transmission and distribution segments, this plan would also entail large capital investments.
At this point, the following challenges face this sector:
Steel and Cement
Steel and cement are important inputs for infrastructure growth and also important indicators of growth in the economy. Steel uses iron ore as a key input and it would be important to have predictability on iron ore prices or at least have these correlated to the prices of steel as most producers do not have captive mines. Further, setting up of steel and cement capacities entails multiple regulatory interventions, land acquisitions and financing, including establishing viability.
Brownfield expansions at existing facilities where possible could potentially augment capacity quicker than possible. Given the ´Make in India´ drive and considering the demand for cement and steel as more industries start establishing manufacturing in India, the government could consider enabling regulation, quicker clearances and some financial incentives for establishing these large capital projects.
Further, the proposed introduction of the Goods & Services Tax (GST) would provide further clarity on the duty and tax structure and tax credits given the inter-State nature of sales in these sectors.
Infrastructure finance has been plagued by viability of projects and banks breaching sectoral exposures on some of the key infrastructure verticals. Other than renewable power and large government-backed urban infrastructure projects, most developers are also not in a financial position to undertake any new projects.
While there have been new policy announcements on InvIT by SEBI, roads and hydropower assets are most likely to benefit from this announcement. Interest for wind power assets will depend on commitment of a pipeline for transfer of additional projects into InvITs. At this point, the industry expects additional clarity on this additional tax and policy announcements around InvITs (specifically on transfer of assets, continuity of the sponsor/developer, etc.), before this can turn into a bankable exit option for developers and investors.
While the last Union Budget emphasised that banks would be encouraged to extend long term loans to the infrastructure sector and that banks would be permitted to raise long-term funds for lending to the infrastructure sector with minimum regulatory pre-emption, a viable solution to solve current exposure of banks to stressed infrastructure projects is critical before additional debt can be provided to new projects.
FICCI Pre-Budget Memorandum
Amendment of Section 80-IA regarding upgrading existing infrastructure Infrastructure development is a prerequisite for the growth and development of any country. Infrastructure development is available in two ways i.e. to build altogether new infrastructure or to convert the existing structure by upgrading it and also enhancing the existing capacity. Both activities entail huge investment and human efforts. It is recommended that a suitable amendment may be made in the Act to clarify that the up-gradation/extension of the existing infrastructure facility would also be eligible for the benefit of Section 80-IA of the Act.
MAT on infrastructure companies
Infrastructure Industry in India has been experiencing a rapid growth with the development of urbanization and increasing involvement of foreign investments. The government has offered various tax incentives under Section 80-IA of the Act to the infrastructure companies to boost infrastructure. The benefit available to the infrastructure companies under the normal provision of the Act gets neutralized since the companies are required to pay MAT on their book profit. To attract more and more investment in infrastructure sector, MAT on infrastructure companies should be abolished.
Restoration of exemption under Section 10(23G)
Section 10(23G) of the Act provided for tax exemption in respect of any income by way of dividends other than dividends referred to in Section 115-O of the Act, interest or long-term capital gains of an infrastructure capital fund or an infrastructure capital company or a cooperative bank from investments made on or after 1st June 1998 by way of shares or long-term finance in approved eligible businesses including infrastructure projects, developers of SEZs, hotel projects of not less than three star category, hospital projects with at least one hundred beds for patients and certain housing projects. The above exemption played a significant role in attracting investment towards development of infrastructure projects in India. However, this exemption was withdrawn by the Finance Act, 2006. In view of the increasing need for huge investments in infrastructure and other vital projects and to ensure low cost of raising capital for such thrust project areas, it is recommended to restore the aforesaid exemption.
Recommendations for the infrastructure sector
The first full Budget of the Modi government provides the ideal opportunity for the FM to fast track investments in the infrastructure asset class through some strategic fine tuning of current investment policies and tax framework.
The infrastructure sector is in dire need of long term investments, fiscal incentives and an investor friendly atmosphere. Here are some recommendations:
Brownfield Projects/General Infrastructure Bonds
Refinancing brownfield infrastructure projects through the existing avenue of Infrastructure Debt Funds (IDFs) should be further explored. Specifically allowing FDI in IDFs established as NBFCs, renstatement of deduction on subscription to infrastructure bonds under Section 80CCF of the Income Tax Act, 1961 (Act) and increase in the minimum limit to at least Rs 50,000 are options to be considered.
National Infra Fund
A National Infra Fund may be created which can be funded through levy of a nominal cess as tax-on-tax on the taxes. Imposing infrastructure cess on a nominal rate on consumption of petrol and diesel, etc., may be considered.
Measures like express exemption from minimum alternate tax for transfer of assets from SPVs to InviTs, abolishing minimum alternate tax applicable for infrastructure projects availing tax holiday under Section 80-IA of the Act, extending the tax holiday to upgrading, refurbishing and augmenting of existing infrastructure and allowing amortisation of development cost under the ´build-operate-transfer´ model are also recommended. Consortiums for EPC and other infrastructure projects should be excluded from the definition of´association of persons´ under the Act.
Allocations to the National Electricity Fund for further interest subsidy loans and debt restructuring to redress the situation of discoms, equity support, debt restructuring and creation of a power sector fund for power generation companies, are some of the options for the power sector. Reinstating depreciation rate on windmills to 80 per cent, service tax exemption to transmission/distribution activities by power generating companies essential for sale of power, extension of benefits of Section 32AC of the Act to power generating companies and discoms, may be considered.
Roads, Ports, Railways, Linkage Projects and Infrastructure Service Providers Creation of a national road infrastructure fund providing interest subsidy loans, for reducing the financial stress on concessionaires is recommended. Dedicated budgetary allocation should be earmarked for public grant (or through VGF) in road and rail road linkages, PPP projects connecting mines and industrial zones to ports. Extension of benefits of Section 80-IA of the Act to the incidental and ancillary support services to Infrastructure Facilities (as listed under 80-IA) may be considered. Further to introducing FDI in key areas, collaboration with States for modernization of railways should receive budgetary support. In the previous budget, the Finance Minister made allocations for Metro projects in two cities. It is recommended that such allocation be made for development of Metro rail projects in other cities as well.
Oil & Gas
Extension of tax holiday under Section 80-IA of the Act to exploration and production of natural gas, extension of deductions under Section 42 of the Act for prospecting, exploration or production expenditure incurred by Indian companies from blocks abroad, extension of duration of benefit under Section 80-IB of the Act from seven years to ten years, extension of such benefits to natural gas under Section 80-IB irrespective of the round of NELP under which the exploration, prospecting or production contract was awarded and exemption from minimum alternate tax are some of the expectations for the oil & gas sector.
To attract greater private participation in the urban infrastructure sector, a change in the viability gap fund regime, by which instead of 20 per cent of the project cost, amounts up to 30 per cent of the total project cost may be financed through VGF, can be considered. The tax holiday under Section 80-IA of the Act should be extended to such urban infrastructure projects by specifically including all such urban infrastructure projects in the definition of ´infrastructure facility´ and not limit it to water supply project, water treatment system, irrigation project, sanitation and sewerage system or solid waste management system.
This article has been authored by Amitabh Sharma, Partner, Khaitan & Co. with assistance from C Nageshwaran, Associate, Khaitan & Co.
This article has been authored by Bhavik Damodar, Partner and COO - Infrastructure and Government Services, KPMG in India, with inputs from Anish Thurthi, Anish De, Amber Dubey and Satrajit Basu.
The information contained herein is of a general nature and is not intended to address the specific circumstances of any particular individual or entity. The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG in India.